How to Avoid (or Escape) the Middle-Class Trap and Retire Early

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2:37Mindy Jensen:You're doing everything right, saving, investing, living below your means, but you still feel completely trapped, like your money isn't accessible and you are chained to your day job. The middle-class trap catches the people who are doing everything right, and most people don't realize they're stuck or how to escape. In today's episode, we're revealing whether this is in fact a trap and exactly how to escape or avoid the middle-class trap entirely.

3:06Mindy Jensen:Hello, hello, hello, and welcome to the BiggerPockets Money Podcast. My name is Mindy Jensen, and with me as always is my not-trapped co-host, Scott Trench. Thanks, Mindy. Great to be here escaping to a great discussion once again with you. You said it today, Mindy. We're going to be talking about what the middle-class trap is. It's a very controversial term. We'll also talk about the controversy behind it. We're going to talk about how to escape it if you're in it, and finally, how to avoid it from the get-go. As everyone knows, I love a good PowerPoint, and today I'm going to share my screen to walk through this.

3:34However, you will be able to follow along if you're listening to the audio only. We will explain everything.

3:38Mindy Jensen:All right, Scott, let's jump into it. What is the middle class trap, Scott? All right. How to escape the middle class trap. Let's start off with what the trap is. And we thought we'd start with an example. So we've constructed Sam here. Sam is a diligent fellow. He's doing all the right things, all the things that personal finance advice tells you to do. Sam is 38 years old. He's married with two kids. He and his wife have a net worth of$1 million. They make$165 ,000 in combined household income per year and have yearly expenses of$110 ,000. These folks have$300 ,000 in a primary residence. That's equity in the primary residence.

4:15The house is worth$650 ,000 and it has a$350 ,000 mortgage attached to it. They have$600 ,000 in retirement accounts. That's$500 ,000 in their 401k and$100 ,000 in their Roth and HSAs. They've done that by diligently contributing to these accounts for a very long period of time. They have two paid off vehicles. They have no personal debt and they have$40 ,000 in an emergency fund. This is not a crazy situation. We've seen a lot of people on BiggerPocketsMoney who have come in some version of this on the podcast here. Right, Mindy? We have.

4:48Mindy Jensen:And I want to point out, Sam's doing great. Sam is setting himself up for a good life. Scott, does Sam want to retire early? I think Sam, I think this situation is the challenge for a lot of folks, right? Because we're kind of in this hybrid world here. Maybe Sam, sure, Sam could be part of the FIRE community, which we primarily talk about here on Bicker Pockets Money, which is the financial independence slash retire early community FIRE. Or he could just be kind of working, enjoying his career and building towards a traditional retirement. But either way, I think the middle class trap speaks to Sam in the sense that Sam is kind of scratching his head.

5:28He's like, what the heck? I'm a millionaire. But if I stop working, I'm going to run out of my money, my$40 ,000 in emergency fund here in like a few months. And we can't sustain our lifestyle on one or just one of our incomes here. And I think that's a very frustrating position that Sam finds himself in. And I think this situation obviously is a privilege and obviously people are going to balk at the fact that we're talking about a millionaire here and calling them a middle class trap victim. But I think it's a pretty common problem inside of the circles of people who watch personal finance YouTube videos or listen to personal finance podcasts with their free time.

6:08I think a lot of people are in this boat in America today, and it's frustrating to not feel flexible or free despite having on paper done everything correct.

6:17Mindy Jensen:Yeah, I completely agree. It looks like he's doing great because he is doing great. He's just not financially independent yet. I think the problem in another way of phrasing this is Sam is still set up to work at least another decade or two before he can really reap the tangible benefits of this sacrifice, The saving and accumulation that he has put himself through for probably 10, 15 years to lead up to this point. Sam's 38 years old. So he's been working probably 13 to 15 years. He's been doing everything right. Yeah, absolutely. And the thing is, though, that that primary residence, he's going to have to pay that mortgage for another 15 to 20 years, right?

7:00And he's got to earn income to pay that mortgage that entire way. So that$300 ,000 in primary residence equity is not helping him. It's not part of his financial portfolio. it's not providing flexibility into his life right now. It may be less expensive than renting at this point on a similar type of residence, but it's still a major cash outlay for him. His retirement accounts are really in his mind, not something he's going to access early at this point. He's maybe not aware even that he can do that to a large degree. He's not going to sell off his vehicles. They're not crazy vehicles. I mean, sure, he could downgrade them to two Corollas or something like that.

7:35But it's not like he's got like, you know, two$60 ,000 vehicles. These are two reasonably safe, probably four wheel drive vehicles. These are kind of vehicles you'd want to safely transport your kids around here in here in a state like Colorado, where there's snowy winters and hilly mountains. And the emergency fund is very responsible. And I think that's that's the core frustration. This is the middle class trap, because even though he's done everything right, it feels like he's got no option but to keep grinding out his job for another 15 to 25 years.

8:01Mindy Jensen:So, Scott, why is the middle class trap so controversial? You alluded to the fact that you got into a bit of a debate in the Choose 5 Facebook group. Yes, yes. We had a very contentious debate about this because people first have a problem with this concept of trap, right? What are we talking about? It's a trap. This person's a millionaire. There are plenty of ways, plenty of mechanisms to access this money early. What are you talking about, Scott? The second component is that people who find themselves in this situation, and so this both angers some people, this term the middle class trap, and it really resonates with, I would say, even more people who feel this way about their situation.

8:44And I think it hurts in a particularly deep way because so many money conscious people follow high quality and correct investing order of operations advice and do that over a very long period of time. Right. They build out that a thousand dollar emergency fund following baby steps like Dave Ramsey's. They attack their bad debt. They take their 401k match. They take free money from their employer if there are specific benefits like an employee stock purchase plan. They fund their emergency account. They max out their HSA. They fully fund their 401k. They max out their Roth IRA. They contribute to our max 529 plans.

9:20And if there's anything left over, they invest in taxable. But they go through this list. But the issue for, I think, most of middle and upper middle class American income earners is you can't go through that whole list. It's just you don't have enough income in order to do that, right? I think the 401k contribution limits for 2026 are going to be$24 ,500 individually. And you can double that if you're married. I think the Roth IRA contribution limits are$7 ,500 per individual. And the HSA limit is like$8 ,550 for a family. Right? So if we add all that up, you're talking about what, like$60 ,000,$70 ,000 in tax-advantaged retirement account savings.

10:02And very few people can, in addition to maxing out those and paying a mortgage, accumulate anything after tax that can provide some of that flexibility or more freeing feeling. That's the problem here is you're doing everything right. And yet none of this money feels accessible in your life today. And that's why it's so controversial. And I think that's why it creates such an emotive response from people when we talk about this concept.

10:31Mindy Jensen:I want to add to this, Scott. You're doing everything right for traditional retirement. But if you are focusing on something non-traditional, you're going to have to get there in non-traditional ways. Yeah, absolutely. And I think there's an obvious point that this sums all this up, right? Which is if 100 % of your disposable income beyond that which you are paying for your lifestyle is going towards your mortgage payment and some version of the retirement account order of operations that I just discussed, then close to 100 % of your wealth is going to be in your home and your retirement accounts.

11:05I mean, it's just that simple and that hard. I think that it's, again, controversial here because the word trap and millionaire really rub some people the wrong way. And it rubs some people the wrong way who have built this position and intend or know how to use it to access or free their lives up. And I think it's hitting other people and resonating with them so hard because it's exactly how they feel. They feel trapped and they feel surprised at having done all these things right for a very long period of time and still completely in their mind stuck at their day job, not able to actually realize any benefits of this wealth.

11:43Mindy Jensen:We have to take a quick ad break, but while we're away, we would love it if you would head on over to our YouTube and subscribe to our channel. That's youtube.com slash biggerpocketsmoney.

11:58Mindy Jensen:Welcome back to the show. Let's go into why Sam is specifically stuck, Scott. So Sam is stuck because his primary residence, again, provides no liquidity debt. $300 ,000 in equity is actually more of even a trap today than it was when we first started talking about the middle class trap five or six years ago, because he can't even refinance that property unless he wants to really jack up his mortgage payment. He's probably got a low interest rate mortgage on that$350 ,000 remaining balance, right? So he can't access that equity. If he wants to borrow against his home, he's going to borrow at seven, you know, six, seven, eight percent for a HELOC.

12:30It's just, it's just inaccessible. The only way he could harness is if he sold the house, moved and pocketed the proceeds of that sale, somehow redeploying them. That's not really realistic in his situation right now. Second, you know, all of his wealth is in his retirement accounts there, and he's not really intending to use those. Those are for future Sam, at least in his mind, not for present day Sam. He does not have enough income to go through that order of operations that we just discussed and begin accumulating wealth after tax, or at least he would feel irresponsible doing that because he's not taking advantage of the tax advantage retirement accounts, right?

13:06That'd be crazy for go to tax advantage advantages in order to accumulate that after tax. And because he spends more than one of the spouse's household incomes, they can't really afford to take risks. Like it's not like he or his spouse could go and start a business or take a sales job and really ramp that up because they spend more than one income alone would provide. So they really need both jobs to stay afloat and not have to tap into that home equity or those retirement accounts. So that doesn't even enable him to take risks in his position. So, you know, a couple other things here, he has cash, he's responsible, but the liquidity is not enough to do anything more than be a buffer between an unexpected layoff or job problem.

13:50It's not really enabling him to take that year off and travel the world or shut that business. The mortgage, again, is a unrelenting payment that he has to make on there. And it's going to be a major fear, I think, inducement and motivation to continue getting a stable paycheck. So and he's not financially independent as a result of this. And I think that's that's the core problem. That's why Sam feels stuck. He feels like he has very little flexibility.

14:12Mindy Jensen:I think that's the bottom line. He is not yet financially independent, even though he has a net worth of a million dollars, I think it's good to remind people your home equity should be counted in your net worth statement, but your net worth statement is not the same as your FI number. Yeah. I think if we even go back here and we look at Sam's net worth, right? A big kind of crushing reality that we need to tell Sam about is, hey, man, you shouldn't really count this$300 ,000 in your primary residence towards your financial portfolio. Count it your net worth, but really the thing that gives you freedom or flexibility is going to be your financial portfolio.

14:50And so you should exclude this home equity and you should exclude your vehicles unless you intend to sell them and redeploy them in either case. So really, Sam, you're worth$640 ,000. Still doing great. That's better than a lot of people in America, but that's the reality of your position, right? Now, even 640 should be providing some kind of freedom. So let's help Sam here. Let's help him figure out what he can do to feel more free, to take some advantage of the great position in a lot of ways that he has built here. What do you think? I think that's great. All right. What do you think Sam's options are here, Mindy?

15:25Mindy Jensen:The first option is that he should run his numbers through a Coast Phi calculator. They will show him that he is Coast Phi. So it's not like all hope is lost. He's doing really great. Coast Phi means You have enough invested now so that you don't have to put more money into your retirement accounts in order to retire at traditional retirement age, which is about 65. I think that's really powerful for somebody to be able to look at this information and say, OK, I am doing well, even though I think I'm in the middle class trap. I'm actually doing OK if I want a traditional age retirement. If Sam does not do anything else and the markets return the long-term average 6-7 % real returns over the next 27 years between his now age 38 and traditional retirement age at 65, he will have a real inflation-adjusted retirement portfolio of$4 million,$3.95 million.

16:29So the core problem here is a lot of people who do follow this financial order of operations investing advice are over saving for retirement. It's a wild concept. Most of America is not saving enough for retirement. Sam may be over saving for retirement. And that's not a bad thing, right? Having extra wealth in retirement, except for Sam is 38. The prime of life is right now. His kids are young right now. He's feeling stuck and trapped right now. Right. And sacrificing 38-year-old Sam so that 65-year-old Sam can have$10 million instead of$4 million may not be a sensible trade-off, right? And we may be over-optimizing for future Sam instead of current Sam.

17:13Again, this is not a common problem across America, but it is potentially common within the community of people who watch personal finance podcasts on middle-class traps, right? So this could be affecting many people watching this video, but it does not affect most people. So if that is the case, if he feels, you know, I'm going to play with this calculator. I'm going to try a 3%. I'm going to try a 4%. I'm going to try a 5%. I'm going to try more conservative, maybe even more aggressive portfolio considerations. But, you know, future Sam's going to have a pretty good retirement, really one way or the other.

17:43I'm going to stop contributing entirely and begin doing something else with that money. Maybe I'll buy real estate after tax. Maybe I'll build an after tax portfolio. Maybe I'll just stockpile cash and put it into a year-long fund to start that business that I've always dreamed of that gives me flexibility to be self-employed. And what I want to call out here is Sam will absolutely forego the tax advantages of a 401k or Roth IRA in this situation. That's a real risk to the advice that I'm suggesting here in this situation. But that also has to be a weight against the fact that he can still invest those dollars.

18:19He's not getting the tax advantage today, but he might do really well with his real estate investment, as good or just as good, even when you consider the tax advantages of a 401k or a Roth outside of those accounts. And they'll produce cash flow that he might feel very comfortable spending for the next 30 years while he leads up to retirement. That business that he starts may do very well. It may pay him much more than his$80 ,000,$90 ,000,$100 ,000 salary within a few years. That could be a really handsome return compared to what he can get in the stock market. You don't have to just blow this money on a boat or your trip around the world.

18:53Just shifting that money from the retirement account contributions to these businesses that you can actively manage and investments you can actively manage may provide multiple sets of benefits that still enable Sam to have a huge. He's still going to have this potential portfolio here, this$3,$4 million retirement portfolio. and he can have plenty of after-tax assets that will get added on top of that. So that's the idea here around declaring Coast Fire and maybe stopping or slowing some of those retirement contributions.

19:23Mindy Jensen:Well, I see where you're coming up with this. What if Sam doesn't want to stop contributing to his retirement accounts? What do his numbers look like if he just keeps going? Let's take a second here and let's put this into the calculator. This is a NerdWallet compound interest calculator. It's free. We have no affiliation with NerdWallet, but we'd love to. So if NerdBallet, if you ever reach out, if you're interested, let us know. We'd love to work together. We'd love some of your products there. But this is a simple, free compound interest calculator that we Googled here. And this is where we're getting this, right?

19:50Sam has$600 ,000 in retirement accounts. That balance, if it grows at 7 % for the next 27 years till his retirement age, will grow to about$3.7 million, depending on, you know,$3.8, depending on whether you want to update it on a monthly or annual compounding basis here. So now your question was, Mindy, what if Sam keeps contributing to those accounts, right? So Sam is contributing, let's say he and his wife are contributing 24.5, the max, to each of their 401k plans, right? Such as$49 ,000 per year. Now that balance is going to go to 7 million. This is assuming a 10 % nominal return from the stock market over the next 27 years and then haircutting 3 % for inflation.

20:32You don't like that number? You can adjust it here and use a 5 % or a 3%. or whatever you think is the correct number here. So there is a component about what you believe here. But if Sam continues to contribute to this, then at some point, I think with reasonable sets of expectations, you're going to have way, way more than you really need or want in retirement. And if the opportunity cost of doing that is feeling stuck between the ages of 38 and 48, so you can have extra millions at 65, that's a bad trade-off for millions or maybe tens of millions of Americans. And I think Sam can then say, you know what, I'm going to start withdrawing from these accounts in five or six years in when my balance will grow to well north of a million dollars at this point in time, if I continue contributing.

21:21All right, we're going to take a quick middle class break. And when we come back, we'll talk about how we can escape the middle class trap. If you've been putting off life insurance, I get it. The old process was miserable. Phone calls with an agent, a nurse coming to your house for a blood draw, then waiting weeks to find out what you'd pay for. That friction is exactly why so many people who should have coverage don't. Here's what I believe. Most BP money listeners need term life, and the right move is to build a ladder. A few term policies of different lengths stack together so your coverage steps down as your mortgage shrinks and your kids get closer to being financially independent or you get closer to hitting your financial independence number.

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